I will be
honest with you, I am not a big fan of Revenue
when it comes to discussing business valuation.
Multiples of revenue are frequently used to determine business value but
I generally dismiss them as misleading or meaningless. I am a firm believer that business value is
driven by earnings. I am also a firm
believer that consistency of earnings is a major factor in reducing business
risk and therefore increasing value.
Even though I
do not place a great deal of reliance on revenue valuation multiples, I must
admit that revenue is where earnings start and therefore the consistency of
revenue can be an important value driver.
The reliability of a recurring revenue model is the epitome of consistent
revenue and therefore consistent earnings.
Given the choice, a buyer will be much more attracted to a business with
a recurring revenue model than one that is not.
One of the biggest concerns business buyers have in an acquisition is
customer retention. Businesses that can
demonstrate a high level of customer retention, lower the acquisition risk for
the buyer and increase the value of their business.
Recurring revenue
comes in many forms and some industries benefit from it naturally. The most obvious of these are industries such
as the utilities, cable & internet providers, cell phone companies,
security alarm monitoring companies and other subscription based companies. Even software developers and IT companies
have created recurring revenue models with the software-as-a-service business
model and the annual service contract. Consumers
of these services are frequently called subscribers. When you can realistically call your
customers subscribers, it is safe to say you have created a recurring revenue
model.
So, what do you
do if you are not in one of these industries and the sale of your product is
not traditionally thought of as a recurring sale? Sometimes it is simply a matter of rethinking
what you do and how you do it; and at other times it may mean you need to
expand your product offering to include a recurring revenue component.
The software
development industry is a great example of rethinking their product offering. Traditionally, software development companies
would package and sell their product for a single, fixed price. Then that industry came up with the idea of
selling a maintenance contract along with the software sale. The monthly, quarterly or annual maintenance
fee became the recurring revenue component.
Then they migrated to the software-as-a-service model where they bundled
the software and the maintenance as a single product with a recurring periodic
payment.
A good example
of the type of company that might have to expand their product offering to
create a recurring revenue stream is a manufacturer or distributor of capital
goods. In addition to the one-time (or
let’s call it periodic) sale of the higher-priced capital goods these companies
began to offer maintenance services or even service contracts. I recently sold a distributor of capital
goods that also offered inspection services to support the equipment they
sold.
Be creative,
rethink and see if there is some way to add a recurring revenue component to
your business. Recurring revenue does
not need to be 100% of your revenue stream but to the extent you can create
some component of recurring revenue you will definitely increase the
attractiveness of your company as an acquisition candidate.
Alan D. Austin,
CFA
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